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Economic Update

 
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Fed Stands Pat, Awaits Solid Economic Evidence

September 18, 2013

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  • Fed Stands Pat, Awaits Solid Economic Evidence

The Federal Reserve failed to confirm market expectations of a tapering of asset purchases and held its asset purchase program unchanged at $85 billion per month. Concerns about the impact of higher interest rates on the economy and the labor market and prospects of a fiscal showdown were factors influencing today’s decision.
Main takeaways from today’s Fed communications:

  1. The recent ascent of interest rates, if sustained, is viewed as a setback to economic activity. Higher long-term rates have already had a pronounced effect on mortgage applications.
  2. Fiscal drag has been a significant headwind to growth, and the uncertain course of current fiscal policy negotiations is being seen as a risk to the outlook.
  3. The Fed’s updated economic projections present a more subdued outlook for growth than the forecast published in June.
    Economic Update September 18, 2013, Chart 1 imageReal gross domestic product (GDP) is now expected to grow 2.0% – 2.3% in 2013 (a downward revision from the 2.6% upper end of the forecast range) and gather momentum in 2014 to register growth of 2.9% – 3.1%. The central tendency for 2014 is a tighter interval and lower compared with the 3.0% - 3.5% forecast of June 2013.

    The Federal Open Market Committee (FOMC) expects the unemployment rate to decline to about 7.2% by year-end and gradually touch a range of 6.4% – 6.8% by the close of 2014. The jobless rate threshold (6.5%) for consideration of a higher federal funds rate has been left unchanged.
  4. The timing of a hike in short-term rates has been pushed out, not forward. While some market indicators reflected a higher funds rate in the latter part of next year, only three members of the FOMC would prefer a higher federal funds rate in 2014.  All but two members of the FOMC expect a higher federal funds rate in 2015.

Bond markets seem to have been caught very much off-guard by today’s news, with the 10-year Treasury yield falling dramatically in the hours afterwards.

Reduction of asset purchases remains on the table, but it is tied to future economic data, not the calendar. In the words of the statement that followed the FOMC meeting, the committee “decided to await more evidence that progress will be sustained before adjusting the pace of its purchases.”

Kansas City Fed President Esther George dissented due to fears about financial imbalance and inflation if the Fed continued on its current monetary policy path. The latter does not seem to be much of a risk; the mid-point of the FOMC’s forecast does not call for inflation to reach its 2% target until after 2016.

Economic Update September 18, 2013, Chart 1 image

The question now becomes, “If not now, when?” We continue to expect that the evidence sought by the Fed will be in hand before the end of the year. Our call for a December start to tapering is based on our expectation of economic progress between now and then and a resolution to the U.S. budget situation. The next scheduled press conference for the Fed leader follows that meeting, which should allow for a healthy discussion of where policy might progress from there.

It is also expected that a nominee to chair the Federal Reserve Board of Governors will have been identified and vetted by then. Chairman Ben Bernanke deflected press inquiries today about the situation with his usual class; expect an announcement sometime before the end of this month.

 

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The opinions expressed herein are those of the author and do not necessarily represent the views of The Northern Trust Company. The Northern Trust Company does not warrant the accuracy or completeness of information contained herein, such information is subject to change and is not intended to influence your investment decisions.
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